No matter how much they earn, people end up living paycheck to paycheck. Whether you are a professional athlete or a student with a side job you might be in this situation. But stay positive, because you are struggling today doesn’t mean there is no hope.
Although, many will have managed to save some money during the pandemic. It’s often down to having fewer opportunities to spend no more clubs, restaurants, or shops. The likelihood of us going on a spending spree diminished greatly.
“Act your Wage”DAve Ramsey
It would be naive to think that once the opportunities return, spending will remain in place. So why not create healthy habits now and protect ourselves from temptation and expenditure?
The vicious circle of living paycheck to paycheck
32%, you read that right 32% of people, surveyed in 2020, were in financial distress. Whether they earned $40,000 or over 200,000 the result was the same 30% or more ran out of money before payday. Unsurprisingly, below that threshold people ran out closer to 40%.
Whether it’s taking on debt early in life or succumbing to Lifestyle inflation. The continuous chase for more leaves many behind grappling at straws. When your checking account approaches the inevitable overdraft – credit cards become a saving grace.
Summers might be easier but when winter hits and the energy bill goes up things can change drastically. That new iPhone or brand new car might seem like only a few hundred per month now… In the long run, monthly payments and debts add up.
“If you can’t pay for it twice cash don’t buy it”Peter Saddington
Lifestyle inflation is the culprit when wages go up, we tend to want to live “our best life”. Worse than that we increase our expenditures with the hope of a windfall. That is nothing short of lunacy. In an episode of the Fast Track Podcast, Peter Saddington shares the spending habits that brought him to 1milion net worth at 26!
Of course, it’s easier said than done once you have reached Financial Independence. Yet you need a backup plan and solutions. Time to dive in:
How to escape living paycheck to paycheck
You aren’t as smart as you think
I know it hurts to hear… But studies show that 71% of people have an inflated perception of their Financial Literacy. Only 34% of people were able to answer basic Financial Literacy questions.
That percentage rings a bell, doesn’t it? There might be no correlation but it seems like an unlikely coincidence. If you want to test your knowledge follow this link.
By accepting our true knowledge we make a giant step towards saving more money. Lower financial knowledge leads to riskier investments. Not only does it mean you are taking more risk you lose track of your portfolio.
Take the time to educate yourself and learn there are many resources out there to get yourself started.
BUDGET BUDGET BUDGET
If you want to get out of this vicious circle… you need to know where your paycheck is going. Track all your expenses and money sinks. Don’t be ashamed of where the money is going but try and understand why you are spending it.
A great rule of thumb as a beginner is to follow the 50-30-20 rule. No more than 50% of your expenses go towards needs, 30% towards wants, and 20% towards savings.
By reverse engineering a budget you can make it fit your lifestyle. The biggest problem with budgeting and following plans is the same as with fad diets. They don’t fit you or your lifestyle.
Build your budget from the ground up to protect yourself from financial trauma. Understanding why you are saving money and where it’s going will also give you a clear purpose. It’s also likely to help you stick to your habits!
Paying back your overdue debt is the highest guaranteed investment you can make. Credit Card debt is typically 15% and higher interest. If you stick to minimal payments and max out your credit line… You will quickly be in over your head.
At a 20% interest rate, your debt will have doubled within 4 years. The compounding effect isn’t always your ally if you aren’t ready for it. Paying back debt should be your number 1 priority.
Debt will trap you into the vicious circle of living paycheck to paycheck.
Our generation deals with a new kind of financial pressure: social media. Seeing people living their amazing lives on Instagram or quitting college to hustle on Twitter… It’s enough to drive anyone incoherent.
Schwab’s “Modern Wealth Survey” showed FOMO is the leading cause for spending. 35% of people surveyed spend more than they can afford to join experiences. 34% will make unexpected purchases based on Social Media.
This is where lifestyle inflation often hits the hardest. Now that your salary has increased you need to show it through your lifestyle. You make $50k a year, so you definitely deserve a brand new BMW worth 40k. It doesn’t matter that you will be making a $600 payment monthly.
The other trap is moving to a higher cost of living area to fit with your new lifestyle. The biggest fixed cost often is rent. Once you’ve signed a contract for 2 years you are stuck. No matter what happens you will be shelling out “the appearance cost” of your apartment.
By “improving” your lifestyle and de facto increasing your expenses you negate the effect of a raise. By relocating to a cheaper neighborhood, downsizing your flat, or finding a flatmate you will effectively decrease costs.
Living in a mansion isn’t worth it if you end up bankrupt. If you want to learn more about how to avoid lifestyle inflation and other financial sins read my article “7 deadly Personal Finance Sins”.
Prepare for the worst
You’ve finally gotten out of debt and cut out most of your superfluous expenses! Congratulations. Unfortunately, you aren’t quite ready to invest yet. I know this feels like it’s taking forever but you are getting there!
Before, investing you need a security net. It will protect you from falling back into old habits and lose all the progress you have made. This magic tool is an Emergency Fund. Typically, an emergency fund is anywhere between 3 and 6 months of expenses saved. Having it at hand guarantees that you are ready for let’s say… a global pandemic?
This is not a future “enjoyment” fund it’s the last resort. Having an emergency fund allows you to keep your head cool when a medical emergency arises or you lose your job. Additionally, you will feel at ease when looking at your bank statements.
Breaking the Vicious Circle!
Now that you have the tools, how are you going to use them? Learning about Personal Finance and how to manage my income has changed my life. I’ve been on this journey for a little over a year now and would love to see you join me!
There is always more to be done and to be learnt. Living paycheck to paycheck isn’t a necessity. What was your first step towards living a Financial Stress-free life?